For those real estate owners and investors
who know how to use it properly, the 1031 exchange can be one of
the most powerful of financial weapons. Named for the section of
the tax code under which it is found, the 1031 exchange allows real
estate buyers to defer the taxes due when they make a qualified
exchange.
The 1031 exchange is also sometimes
referred to as the like-kind exchange, and in fact the purpose of
this program is to allow buyers to exchange one income producing
or investment property for another similar property.
The 1031 exchange allows real estate
owners to defer all of the capital gains taxes resulting from the
sale of an investment property. In order to take advantage of this
program, the buyer must use a qualified intermediary, they must
follow the guidelines established by the IRS, and they must use
the proceeds of the property sale to purchase a similar investment
property within 180 days of the original sale date.
In order to be eligible for the full
1031 exchange benefit, the replacement property must be of equal
or greater value as the property being sold, and it must carry an
equal or greater amount of debt as the property that was sold. This
rule can be waived if the taxpayer adds cash to the deal in order
to replace the debt. All proceeds from the sale of the original
property must be used in the acquisition of the replacement property
in order to qualify for the benefits of the 1031 exchange.
In addition, the taxpayer must assign
the interest in the original property to a qualified intermediary
before the closing of the sale. This ensures that the taxpayer has
relinquished control of the funds prior to the actual sale.
After the closing of the original
property, the proceeds will be sent to the qualified intermediary
by the closing agent. This intermediary will retain control of the
funds until the transaction for the replacement property is ready
to close. The proceeds from the sale of the original property will
then be deposited to the purchaser by the qualified intermediary.
The funds will then be delivered to the taxpayer, completing the
tax free 1031 exchange.
The advantage of the 1031 exchange
is obvious to real estate owners and investors, and this provision
of the tax code has become quite popular in the years since it was
originally introduced. The idea behind the 1031 exchange is that
the taxpayer should have the ability to sell one investment property
and freely exchange it for a like property without being burdened
with capital gains taxes. Since the funds derived from the original
property are never actually received by the taxpayer there is no
taxable transaction and thus no taxes are due.
The provisions of the 1031 exchange
have opened up many new avenues for owners of income producing properties
and real estate investment properties. Those investors and real
estate owners who own investment property no longer need to feel
trapped in a property that did not work out the way they had hoped.
Instead those investors now have the ability to more easily exchange
that less than suitable investment property for a more suitable
investment opportunity. This new provision of the income tax code
has certainly opened up new avenues and new opportunities, and it
is easy to see why the 1031 exchange has become such a popular choice
for real estate owners and investors.
